DEALBOOK; Facebook's Google Effect

By ANDREW ROSS SORKIN

Published: January 11, 2011

''I hope the only people harmed are speculators.''

Roger McNamee, the venture capital investor, was discussing the new race in Silicon Valley to buy up shares of hot private Internet companies in the wake of Facebook's $2 billion fund-raising last week that valued the company at $50 billion.

Mr. McNamee, a co-founder of the private equity firm Elevation Partners, whose best known principal is the musician Bono, knows a thing or two about the shadowy markets where private start-ups like Facebook trade hands.

But Mr. McNamee is starting to worry about a spate of copycat offerings that may come along in the coming months from dozens of Internet companies spurred by overzealous investors.

''If history is any guide, both sides will eventually overplay their hand on this, eventually leading to problems,'' he said, resigned that the boom in private fund-raising may end badly.

Venture capital investments used to be made only by venture capitalists - professionals with an appetite for risk. But today, with billion-dollar rounds of fund-raising for the likes of Facebook and Groupon, money is flowing into these businesses from big institutional investors to wealthy individual clients of Goldman Sachs to plain old retail investors.

(Groupon, for example, raised $950 million on Monday; the company put out a hilariously headlined press release: ''Groupon Raises, Like, a Billion Dollars.'')

Then there are more indirect ways to buy into the hot private stocks. Some financial firms are creating vehicles, giving wealthy individuals a chance to get in on the action in secondary markets, where Facebook, Groupon, Zynga and other tech start-ups are trading at a frenetic pace.

Last week, a group of technology executives started a closed-end mutual fund that will try to buy shares directly from companies or on private exchanges. Think of the soon-to-be publicly traded NeXt BDC fund as away for mom and pop to acquire shares of Facebook without being a wealthy client of Goldman Sachs.

According to Mr. McNamee, investors are handing over money by the boatload because of a deep-seated insecurity of missing the next big thing. Call it the Google Effect.

''Almost every institutional investor screwed up Google's I.P.O by not buying aggressively. No one wants to repeat that mistake with Facebook,'' said Mr. McNamee, referring to the fact that Google's original price at its public offering was a measly $85 a share; the company's shares closed on Monday at $614.21.

Memories might be long about the Google I.P.O., but that does not mean that investors should take the plunge. Those heaving money at companies like Facebook are doing so with only a modicum of information about the companies' performance. In the case of Facebook, investors were told only about the company's revenue and profit for the last two years - hardly the kind of granular detail that most investors, even rich ones, typically require.

''Let's call a spade a spade,'' said Barry Schuler, managing director of the venture capital firm Draper Fisher Jurvetson. ''This is a faux I.P.O., no matter how you slice it,'' he said of last week's private Facebook offering.

Investors ''are just going on Goldman's word and Facebook buzz, and they're bypassing all the regulation that a public company has to comply with.'' He added, ''A lot of people are stepping back and saying, 'Isn't this the kind of behavior that created the last two meltdowns?' ''

Not all Wall Street denizens are worried. ''It's high stakes. But I don't think it should be outlawed,'' said Alan J. Patricof, a longtime venture capitalist who was an early investor in Apple. ''There's a large amount of individual investors that would like to participate in this. It may be a new really late stage form of venture capital.''

For companies, raising money in the private market over pursuing an I.P.O. makes eminent sense. ''An I.P.O. is like a bomb,'' Mr. Mr. McNamee said, ticking off a list of downsides of going public: extra scrutiny, compliance costs and schadenfreude from rivals.

''It creates a big crater, whereas these private offerings are like a laser beam. They allow issuers to raise large amounts of capital with a minimal regulatory or governance burden.''

And for investors, ''the benefit of these deals is the ability to buy a substantial block of stock, something that is not possible in the I.P.O. market,'' Mr. McNamee said.

These late-stage offerings also allow liquidity for company executives and early investors, allowing them to take a bit of risk off the table. Groupon, for example, might allow its board to cash out as much as $344.5 million as a result of its latest fund-raising effort.

All that may be good for top company executives and employees, but is it good for long-term investors? Are companies going to take bigger risks or less once they've already partially cashed out ahead of a potential I.P.O.?

Peter Thiel, a venture capitalist who is a board member of Facebook, said at a last fall's TechCrunch conference that one of his investment criteria for early stage companies was this: ''The lower the C.E.O. salary, the more likely it is to succeed.''

He may now have to change his investment thesis.

Evelyn M. Rusli contributed reporting.

This is a more complete version of the story than the one that appeared in print.

PHOTO: Roger McNamee, of Elevation Partners, expects a bad end to the private fund-raising boom. (PHOTOGRAPH BY FRED R. CONRAD/THE NEW YORK TIMES) (B8)